Demand, Supply, and Market Equilibrium

Chapter 3

Prepared by: Fernando & Yvonn Quijano

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair CHAPTER 3: Demand, Supply, and Market Equilibrium © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair and Market Equilibrium Demand, Supply,

the the Resourcesof Allocation Looking Markets and Ahead: Demand and Supplyin Product Markets: Changes Equilibriumin Excess Supply Excess Demand Market Equilibrium From IndividualSupply to SupplyMarket Shift of Supply Movement versus Other Determinants of Supply Price and QuantitySupplied: The Law of Supply Markets Supply inProduct/Output From Household to Demand Demand Market Shift of versus Demand Movement Other Determinants of Household Demand Price and Quantity Demanded: The Law of Demand Changes Quantityin Demanded versus Markets Demand in Product/Output Markets: Input Markets and Output Firms Households: and AReview along a SupplyCurve along a Demand Curve Changes in Demand CircularThe Flow BasicThe Decision

Chapter OutlineChapter

- Making Units Making

of 46 of

CHAPTER 3: Demand, Supply, and Market Equilibrium THE BASIC DECISIONTHE BASIC FIRMS HOUSEHOLDS:AND © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair economy. households anda business. turningitinto successful firm, product or a newidea taking anew risksofmanages, andassumes the a entrepreneur inmarket a producingunitseconomy. (outputs). Firms primary are the resources (inputs)into products firm

An organization that transforms that transforms An organization

The consuming unitsin an The consuming

A organizes,whoperson - MAKING UNITS MAKING

3 of 46 of

CHAPTER 3: Demand, Supply, and Market Equilibrium THE CIRCULAR FLOW THE CIRCULAR INPUTMARKETS MARKETS:OUTPUTAND © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair products are exchanged. to producethe which resources used input or factor markets are exchanged. markets goodsinand services which product or output markets

The markets in The

4 of 46 of

The Circular Flow of Economic Activity

5 of 46 of

CHAPTER 3: Demand, Supply, and Market Equilibrium THE CIRCULAR FLOW THE CIRCULAR INPUTMARKETS MARKETS:OUTPUTAND © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair to goods.buy capital future profits, to firms funds that demand savings, for interest orfor to claims intheirsupplyhouseholds which capital market wages labor. to that firms demand inworksupplyhouseholds for which labor market

The input/factor market The market input/factor

The input/factor market

6 of 46 of

CHAPTER 3: Demand, Supply, and Market Equilibrium THE CIRCULAR FLOW THE CIRCULAR INPUTMARKETS MARKETS:OUTPUTAND demanded and the quantities and typesof inputs supplied. quantities of inputs demanded. Households determine the typesand quantities of products Firms determine the quantities and character of outputs produced and the typesof Input and output markets are connected through the behavior of both firms and households. © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair production. capital three key factors arethe of the process.production Land,labor, and factors of production for exchangerent. real propertyin or whichsupplyhouseholdsother land land market

The input/factor market The market input/factor in

The inputsinto

7 of 46 of

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair number of factors including: particular output, or product, to demand depends on a A household’s decision about what quantity of a ■ ■ ■ ■ ■ ■

income, income, wealth, and prices The household’s The household’s household The wealth The household’s The The income available price of the product prices prices of other products

expectations tastes and preferences amount of accumulated

to the household

in question

available to the about future

8 of 46 of

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair market market price. it buyit could allwantedat the current if inperiodgiven a buy wouldhousehold (number ofunits)of a productthat a quantity demanded

The amount

9 of 46 of

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND demand for most goods. demanded in the price of Coca other factor, such as income or preferences, affect Changes in the price of a product affect the VERSUSIN DEMANDCHANGES CHANGESIN QUANTITY DEMANDED © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair . . However, we saythat an increase in income is likelyto cause an increase in the market pricequantity and demanded. markets is thatbetweenindividual inThe most important relationship - Cola is likelyto cause a decrease in the

quantity demanded demand . . Thus, we saythat an increase quantity of Coca

per period. Changes in any

- Cola

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND THE LAWOF DEMAND PRICE QUANTITYAND DEMANDED: prices. buy at different to wouldbe willing product a household much of a given Ahow showingtable demand schedule © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair

TABLE 3.1 PRICE (PER CALL) $ 0 15.00 10.00

7.00 3.50 .50 Anna’sDemand Schedule for Telephone Calls

QUANTITYDEMANDED (CALLSPERMONTH)

25 30 0 1 3 7

of 46 of

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair would be willing to wouldbuybe atdifferent willing prices. much of aproducthousehold given demand curve

Ahowillustrating graph FIGURE 3.2

Anna’s Demand Curve

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND curves have a negative slope. and to expect quantitydemanded to rise when price falls, ceteris paribus. Demand It is reasonable to expect quantitydemanded to fall when price rises, ceteris paribus, DemandSlope Curves Downward © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair quantity demandedincreases. decreases. demanded falls, As price demanded: rises, quantityAs price quantityprice and betweenrelationship law of demand

The negative

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND in a given period of time is limited, if onlyby time, even at a zero price. That demand curves intersect the quantity axis is a matter of common sense. Demand are ultimately constrained, or limited, byincome and wealth. will not, or cannot, pay.Even if the good or service is veryimportant, all households the price axis. For anycommodity, there is always a price above which a household Aslong as households have limited incomes and wealth, all demand curves will intersect Other Other Properties of DemandCurves © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair Anna’scurve. demand Twothings aboutadditional arenotable

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND demand curves: Tothe of shapewhataboutwe know summarize 3. 2. 1. © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair

limited incomes and wealth.andlimited incomes They intersect the price(Y utility. marginal of diminishingand time limitations They intersect the quantity(X demanded. is to likelyleadto inan quantity increase inanddecrease price quantity a demanded, into leadto a price islikelydecrease Theyslope. a havenegative inAn increase

- ) axis, aresultof

- ) axis,result a

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND OTHER OF DETERMINANTSDEMANDHOUSEHOLD Income and Wealth © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair owes. It is astock measure. what whatownsminusa household it wealth or net worth of time. given It period is aflow measure. rents, other and forms a of inearnings profits, wages, salaries,interestpayments, income

The of sum allahousehold’s

The total value of The total value

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair tends to fall when income rises. tends incometo fall when inferior goods is lower. incomewhen goeswhichdemand down goes upand whenincomeis higherfor normal goods

Goods for whichdemand Goods for demandwhich

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND Prices of OtherGoods and Services © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair demand forthe other,versa. and vice the inan increase of one results in price Goods that “go together”: a indecrease complements, complementarygoods perfect substitutes other up. goes for price ofdemand the increases,one the replacementsfor one when another: substitutes

Goods that serve can as

Identical products.

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND Expectations Tastes and Preferences © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair

as goodas another. daythe in desert,one brand is Perfect substitutes?On ahot

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND TABLE 3.2 $ 0 $ (Per (Per Call) 10.00 20.00 15.00 7.00 3.50 Price A DEMANDCURVE SHIFT VERSUSOF DEMANDMOVEMENT ALONG .50

Shift of Shift Anna’s Demand Schedule Due to increase Due increase toIncome in (Calls (Calls Per Month $300 $300 Per Month) at at of an Income SCHEDULE D Demanded Quantity 25 30 0 0 1 3 7

(Calls (Calls Per Month $600 $600 Per Month) at at of an Income SCHEDULE D Demanded Quantity

12 18 33 35 0 2 7

FIGURE 3.3

Following a Rise in Income Shift of a Demand Curve

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND Change in price of a good or service Change in income, preferences, or prices of other goods or services leads to leads to © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair in price. broughtaboutby achange in demanded quantity movement along a demand curve conditions.original The shiftthe by isinabouta change brought of that andof a demanded price good good. to betweena newquantity relationship takes curvecorrespondingindemand a place shift of a demand curve Change in Change in

demand quantity demanded

(shift of the demand curve).

(movement along the demand curve).

Thethat change

The change

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND FIGURE 3.4 © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair

along a Demand Curve Shifts versus Movement

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium DEMAND IN PRODUCT/OUTPUT MARKETS IN PRODUCT/OUTPUT DEMAND MARKET DEMAND FROM HOUSEHOLDTODEMAND © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair the forthat market or service.good per periodinbuyingby allthe households quantitiesdemandedor service ofagood market demand

The of sum allthe

of of 46

Deriving Market Demand from Individual Demand Curves

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium SUPPLYMARKETS INPRODUCT/OUTPUT © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair costs them. to produce are ableto selltheir products for more than it Successful they firms becausemake profits and costs. profit

The differencebetweenrevenues

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium SUPPLYMARKETS INPRODUCT/OUTPUT THE LAWOF SUPPLY PRICE QUANTITYAND SUPPLIED: © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair particularduringa givenpricetime period. to offerableand willing for at asale particularproduct that abe would firm quantity supplied

Theof a amount

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium SUPPLYMARKETS INPRODUCT/OUTPUT © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair prices. much of a product sellat will firms different supply schedule TABLE 3.3

PRICE (PER BUSHEL) $1.50 5.00 4.00 3.00 2.25 1.75

Clarence Brown’s SupplySchedule for Soybeans

Ahow table showing

(BUSHELS PERMONTH) QUANTITYSUPPLIED 45,000 45,000 30,000 20,000 10,000 0

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium SUPPLYMARKETS INPRODUCT/OUTPUT © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair a decrease in quantity supplied.a indecrease quantity and a leadmarket priceto decreasein will supplied,inlead quantity toan increase supplied: willin price market An increase quantityof aand between good price law of supply

Therelationship positive

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium SUPPLYMARKETS INPRODUCT/OUTPUT FIGURE 3.6 © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair different prices. much of aat sell product a firm will supply curve

Individual SupplyCurve Clarence Brown’s

Ahowillustrating graph

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium SUPPLYMARKETS INPRODUCT/OUTPUT OTHER OF DETERMINANTSSUPPLY The Cost ofProduction © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair firm firm to make aprofit. exceedthe cost the of producingoutput for the command forits must product,revenue of the that Regardlessprice a firm can

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium SUPPLYMARKETS INPRODUCT/OUTPUT Assumingthat its objective is to maximize profits, a firm’s decision about what quantity of output, or product, to supplydepends on 3. 2. 1.

The prices of related products ■ ■ The cost of producing the product, which in turn depends on The price of the good or service The of ProductsPrices Related

© 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair The technologies that can be used to produce the product The price of required inputs (labor, capital, and land)

market. that suppliesto soybeansthe A farm soybeanis aproducer

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium SUPPLYMARKETS INPRODUCT/OUTPUT A SUPPLYCURVE SHIFT OF SUPPLYVERSUSMOVEMENT ALONG © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair change in the original conditions.changethe inoriginal good. The is shift aboutby a brought suppliedof a goodand theprice ofthat quantitybetween to a new relationship takes incurve correspondingsupply a place shift of a supplycurve by ina price. change about brought changequantitysupplied in movement along a supplycurve

Thethat change

The

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium SUPPLYMARKETS INPRODUCT/OUTPUT TABLE 3.4 (Per (Per Bushel) $1.50 5.00 4.00 3.00 2.25 1.75 Price

QuantitySupplied (Bushels (Bushels Per Year Using Old Seed) Using Old SCHEDULE SCHEDULE D - 45,000 45,000 30,000 20,000 10,000 Resistant Seed Strain 0

QuantitySupplied (Bushels (Bushels Per Year Using New Using Seed) New SCHEDULE SCHEDULE D 54,000 54,000 40,000 33,000 23,000 5,000

FIGURE 3.7

Seed Strain Following Development of a New Shift of SupplyCurvefor Soybeans

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium SUPPLYMARKETS INPRODUCT/OUTPUT Change in income, preferences, or prices of other goods or services Change in price of a good or service

© 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair shifts in supply curves (changes inshifts supply):curves (changes in supply and supplied)curves in(changes quantity supply movements alongbetween distinguish As with demand,is very it important to leads to leads to Change in Change in

supply quantity supplied (shift of a supplycurve).

(movement along a supplycurve).

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium SUPPLYMARKETS INPRODUCT/OUTPUT FROM INDIVIDUALSUPPLY TO MARKETSUPPLY © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair singleproduct. of a producersby all period each supplied market supply

Thethat of sum allis

of of 46

Deriving Market Supplyfrom Individual Firm SupplyCurves

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium MARKET EQUILIBRIUM MARKET © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair is no tendencyfor to pricechange. are equal.demanded there At equilibrium, and quantity suppliedwhen quantity equilibrium

The condition that existsThe condition

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium MARKET EQUILIBRIUM MARKET EXCESSDEMAND © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair quantity supplied at the current at thecurrent price. quantity supplied exceedsthat quantitydemandedexists when excessdemand or shortage

and quantitysuppliedequal. up quantitywithdemanded withdemandexcessandends Biddingat auctionstarts an

The condition

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium MARKET EQUILIBRIUM MARKET reached at which quantitydemanded and quantitysupplied are equal. a market rises, quantitydemanded falls and quantitysupplied rises until an equilibrium is When quantitydemanded exceeds quantitysupplied, price tends to rise. When the price in © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair FIGURE 3.9

Excess Demand, or Shortage

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium MARKET EQUILIBRIUM MARKET EXCESSSUPPLY © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair quantity demanded at the current at thecurrent quantityprice. demanded exceedsthat quantitysuppliedexists when excesssupply or surplus

The condition

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium MARKET EQUILIBRIUM MARKET demanded are equal. to increase until an equilibrium price is reached where quantitysupplied and quantity fall. When price falls, quantitysupplied is likelyto decrease and quantitydemanded is likely When quantitysupplied exceeds quantitydemanded at the current price, the price tends to © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair

FIGURE 3.10 Excess Supply,or Surplus

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium MARKET EQUILIBRIUM MARKET CHANGESIN EQUILIBRIUM © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair equilibrium price andprice quantityequilibrium change. curves shift, andWhen the demand supply

FIGURE 3.11 The Coffee Market: AShift Price Price Adjustment of Supplyand Subsequent

of of 46

FIGURE 3.12 for Product X and Demand Shifts Examples of Supply

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium A REVIEW DEMAND SUPPLYAND MARKETS: IN PRODUCT 5. 4. 3. 2. 1. of supply and demand in product markets: Here are some important points to remember about the mechanics 6.

the current price. Market equilibrium exists only when quantitysupplied equals quantitydemanded at anyother factor changes, the curve shifts, or changes position. demanded or supplied changes shifts of these curves. When the price of a good changes, the quantityof that good Be careful to distinguish between movements along supplyand demand curves and and input prices. products. Costs of production are determined byavailable technologies of production The supplyof a good is determined by price, costs of production, and prices of related other goods and services, tastes and preferences, and expectations. The demand for a good is determined by price, household income and wealth, prices of per month, or per year. Quantity demanded and quantitysupplied are always per time period would supply if it could sell all it wanted at the given price. all it wanted at the given price. Asupply curve shows how much of a product a firm Ademand curve shows how much of a product a household would buy if it could buy © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair

— that is, a movement occurs along the curve. When

— that is, per day,

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium ALLOCATIONOF RESOURCES LOOKING MARKETS AHEAD: THE AND © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair what is is produced. what who gets and it isproduced, how is produced, of what questions economic basic the answer You markets how see to begin already can ■ ■ ■

continue continue buying do so; others stop buying. As it does, those who are and willing able to When a good is in short supply, price rises. profits. technology good reason to choose the best available Firms business in to make a profit have a prices of other goods, and expectations. influenced by incomes, wealth, preferences, willing and able to pay for products; they are Demand curves reflect what people are

— lower lower costs mean higher

of of 46

CHAPTER 3: Demand, Supply, and Market Equilibrium REVIEW TERMS CONCEPTSAND law demand of land market labor market markets factor input or inferior goods income households firm of production factors surplus or excess supply shortage or excess demand equilibrium entrepreneur schedule demand curve demand complementary complements, capital market © 2007 © 2007 Prentice Hall Business Publishing Principles Economics of 8e by Case and Fair

goods

wealth or net worthnet wealth or supply schedule supply curve substitutes curve supply a shift of curve demand a shift of quantitysupplied quantitydemanded profit markets output or product substitutes perfect goods normal curve asupply along movement curve ademand along movement supply market demand market law supply of

of of 46